Chancery Court Dismisses Stockholder Claim For Breach Of Fiduciary Duty, Despite Board’S Inaccurate Disclosures
In Steven H. Busch v. Edward J. Richardson et. al. and Richardson Electronics, Ltd., C.A. No. 2017-0868-AGB (Del. Ch. November 14, 2018), the Delaware Court of Chancery (the “Court”) dismissed a plaintiff’s stockholder suit against certain board members of Richardson Electronics Ltd. (the “Company”) for breach of fiduciary duty. The Court found that the Company’s board (the “Board”) exercised valid business judgment in rejecting the plaintiff’s demand to unwind certain Company transactions, despite the Board’s failure to disclose certain related party transactions to the plaintiff and other stockholders.
In 2016, the Board formed a special committee (the “Special Committee”) to investigate a demand by Steven Busch (“Busch”), a stockholder of the Company, to unwind and rescind certain transactions between the Company and its CEO Edward Richardson (“Richardson”). The Special Committee was tasked with producing a report detailing its findings (the “Report”). The Report indicated that beginning in 2012, the Board authorized the Company to enter into various stock repurchase plans directing the repurchase of Company stock through brokers when its stock price fell below certain thresholds. The Board gave Richardson unilateral authority to adjust these thresholds within a certain range. In May 2013 and October 2014, the Company repurchased a number of its shares from Richardson Wildlife Foundation, a charity Richardson allegedly controlled (the “Transactions”). The Transactions were not executed under the Company’s stock repurchase plans or through brokers. No documents were produced reflecting Board approval of the Transactions or compliance with the Company’s insider trading policy.
The Company elected not to disclose the Transactions to its stockholders until August 2015, based upon advice from the Company’s auditor and legal counsel. These public disclosures claimed that the stock repurchases were approved by the Board. Despite these inaccurate disclosures, the Report recommended rejection of Busch’s demand, concluding that it was unclear whether the Company was harmed as a result of the Transactions, while also considering the significant costs of bringing a lawsuit. Busch then brought his suit against five members of the Board for breach of fiduciary duty.
The Court first addressed a number of Busch’s claims by applying the Spiegel test, which addresses the scenario where a plaintiff chooses to make a demand on the board and the demand is rejected. In such case, the plaintiff is deemed to have conceded that the board has the requisite independence and disinterest, and the only remaining question is whether there is any reasonable doubt as to the board’s valid business judgment, which requires due care and good faith. Busch pointed to a number of facts to argue that the Special Committee had not acted with due care and good faith, including the Special Committee’s failure to assess Delaware law as applicable to related party transactions, and its failure to properly investigate Richardson’s unilateral amendment to the Company’s stock repurchase plan. The Court rejected these arguments, noting the fact that the Report addressed each of Busch’s claims indicated that the Special Committee had investigated each of these issues. The Court also noted that in producing the Report, the Special Committee was advised by prominent legal counsel and external auditors, further supporting the defendants’ argument that the Special Committee had taken sufficient steps to investigate the issued raised by Busch.
The Court then addressed the argument that Busch was “actively misled” to believe the Board played no role in the Transactions, and he should therefore be treated as if he never made his demand. The Court noted that under the Rales test, demand may be excused where there is reasonable doubt that at least half the board members are not independent and disinterested. If a court finds that demand is excused, the court may apply the Zapatatest in the case where a special committee attempts to dismiss a properly initiated derivative suit. In that specific scenario, the court will examine the independence and good faith of the special committee and determine, applying its own business judgment, whether a motion to dismiss the plaintiff’s claim should be granted.
In this case the Court found that the Board and the Company did indeed make inaccurate disclosures, and therefore it would be inequitable to hold Busch to the concession that the Board was independent and disinterested. However the Court refused to apply Zapata, on the basis that the narrow scenario required for application of that test was not present here. Instead, the Court applied the Rales test to determine whether demand would have been futile. The Court found that a majority of the Board did not receive any financial benefit from the Transactions, nor did a majority of the Board have a substantial risk of liability with respect to the Transactions (which would have incentivized them to reject Busch’s demand). As a result, the Court determined that, even if it disregarded the fact that Busch made a litigation demand and the test for demand futility were applied, Busch’s complaint would be dismissed.